China studies taxing government bond interest income - Bloomberg

China is conducting a survey on potentially levying a 25 percent income tax on interest earned from government bonds, Bloomberg reported on Wednesday, citing people familiar with the matter, a move that could lift local bond yields from historic lows.

Currently, both enterprises and individuals in China are exempt from income tax on interest generated from central and local government bonds. Scrapping the corporate exemption would bring the levy in line with the standard corporate income tax rate of 25 percent.

China’s central bank surveyed some banks last month to gauge how tax on sovereign and local government bond interest would affect their appetite for holding the debt, the report said. The People's Bank of China asked lenders to specify whether their willingness to hold such bonds would drop by less than 10 percent, 20 percent, 30 percent, or by more than 30 percent.

The survey does not indicate whether or when existing policy might change, the report added.

Rolling back the tax breaks would align with Beijing's broader push to bolster fiscal revenue amid a sharp slump in land sales. However, taxing bond interest would also drive up yields as investors demand higher returns to compensate for the tax burden, ultimately raising government borrowing costs if investors sell off holdings. Concerns over sluggish domestic economic growth and falling equities have pushed China's benchmark 10-year sovereign bond yield steadily lower this year.

Commercial banks would bear the brunt of such a policy shift, as they are the largest holders in China’s roughly 100 trillion yuan central and local government bond markets, holding more than 60 percent of each, Finance Ministry data shows.

Market participants have begun estimating the potential fallout of the tax:

• Huatai Securities estimated that fully pricing in a 25 percent interest income tax would theoretically require the 10-year sovereign bond yield to rise by 52 basis points to maintain current after-tax returns, though actual yields on newly issued 10-year debt might only climb 10 to 20 basis points.
• Guohai Securities noted a similar upward effect on local debt, projecting that 10-year local government bond yields would theoretically need to rise from 1.68 percent to 2.25 percent, though the actual market impact would likely be smaller.
• Tax Burden: In a report earlier this month, Huatai Securities estimated that taxing existing bond holdings would saddle institutional investors with 459 billion yuan in additional annual tax liabilities. If the tax is only applied to newly issued bonds, the first-year burden would be roughly one-tenth of that amount.

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